Assume you are the manager of a $100 million portfolio of corporate bonds and you believe interest rates will fall. What adjustments should you make to your portfolio based on your beliefs?
As the manager of a $100 million portfolio of corporate bonds, I believe that interest rates are going to fall. Knowing that “bond prices and interest rates always move in opposite directions” (Ross, S. A., Westerfield, R., & Jordan, B. D., ...view middle of the document...
With this, this would cause the $100 million portfolio of bonds I manage to have a coupon rate higher than that of the market rate, and for them to be worth more than that of their face values. As such, these bonds would be considered to be premium bonds, and investors would be “willing to pay a premium to get this extra coupon amount” (Ross, S. A., Westerfield, R., & Jordan, B. D., 2013).
Based on my beliefs, an adjustment I should make to my portfolio would be to sell some of the shorter duration bonds I currently manage, and purchase more with longer times to maturity. Because long duration bonds are more sensitive to interest rate changes, the more the interest rates fluctuate, the more change I should expect to see in the bond’s value. And, with my belief that interest rates are going to fall, the longer the times to maturity that the bonds in the portfolio I manage have, the more substantial the changes I should expect to see in their values- and in the case, to my benefit! :-)
Ross, S. A., Westerfield, R., & Jordan, B. D. (2013). Fundamentals of corporate
finance. New York, NY: McGraw-Hill/Irwin.